This drop brought the Dow to its lowest level of 2022 and placed it in bear market territory — commonly defined as a drop of 20% or more from recent highs — before a slight rebound at the end of the trading day. The Dow still closed in the red, with a single-day loss of 1.6%.
This latest loss comes after a tumultuous week for the stock market. Stocks fell on Wednesday after the Federal Reserve announced its third consecutive 0.75% rate hike, as fears about the central bank’s increasingly hawkish stance and a potential recession on the horizon spooked investors. Signs of persistently high inflation August’s Consumer Price Index (CPI) report also sparked a sharp market decline last week.
The 0.75% rate hike was in line with most investors’ expectations and not necessarily the main reason behind the market’s drop on Wednesday. “The real thing that happened [Wednesday] that’s leading to the market’s [reaction] is that [Federal Reserve Chairman Jerome] Powell reset the terms of where the Fed is going at the press conference,” says Brad McMillan, CIO for Commonwealth Financial Network.
According to the Federal Reserve’s FOMC statement, the central bank is “strongly committed to returning inflation to its 2 percent objective” and “anticipates that ongoing increases in the target range will be appropriate.” Powell’s statements in the press conference following the statement’s release further supported that message.
“[Powell] came as close as he possibly could to say, ‘yes, we’re going to get inflation down, even if it means tightening to a recession,’” says McMillan. Powell’s statements changed investors’ expectations for what the Fed will do in the near future, and the market is pricing in expectations of higher interest rates for longer, he explains.
Investors can expect more volatility in the stock market in the days and months ahead, as the Fed continues its efforts to tamp down inflation and investors respond. It’s impossible to time the market, so experts recommend staying the course and dollar-cost averaging your long-term investment goals.
“Historically, the stock market has come back from crashes [and] bear markets,” says Daniel Demian, strategic advisor at Albert, an automated money management and investing app. “As long as you’re properly diversified…you shouldn’t have any reason to worry.”
Why the Federal Reserve Is Raising Interest Rates Right Now
Two of the Fed’s central mandates are to maintain low unemployment and keep prices stable. It does that through monetary policy, including adjusting the money supply in the country to make interest rates move toward the target rate they set.
Higher interest rates mean higher costs of borrowing for businesses and individuals, which is supposed to cool down demand and reduce the growth in prices. However, raising interest rates too high could potentially lead to an economic recession and higher unemployment, which the Fed wants to avoid.
Inflation spiked in mid-2021 due to a combination of factors, including supply chain issues and demand imbalances stemming from the COVID-19 pandemic, and has remained persistently high ever since. As a result, the Fed has instituted a series of rate hikes since March in an effort to slow down the economy and get inflation back under control.
How the Federal Reserve’s Rate Hikes Affect the Stock Market
How quickly, and by how much, the Fed increases interest rates can affect how investors see the central bank’s monetary policy going forward. “If they [hike rates] higher than expected, then the Fed is seen as being more hawkish,” says Demian. That could turn off some investors who fear that higher rates will lead to higher prices to be pushed down to consumers, leading the economy further down the path to a recession.
Hiking rates less than expected is more what the market wants to see from the Fed right now, says Demian. “A lot of participants are calling for the Fed to slow down [on its rate hikes]. [If it does,] that could be a good sign for the market and that could cause a bit of a rally.”
But more importantly, the Fed needs to be consistent in order to maintain its credibility.
“If [the Fed] starts to flip flop on their position, then they risk being not credible, which could also lead to a market sell-off,” Demian says. “So they have to be very careful about their comments, not to seem too hawkish, not to seem too [dovish], and to maintain their credibility.”
Are We in a Recession?
The U.S. GDP contracted in the last two quarters, meeting one definition of a recession.
Economists say it’s too early to tell if we are in a true recession, but the technical definition of a recession is of little concern to Americans who are dealing with soaring prices, rising interest rates, and job layoffs.
The labor market is caught between wage growth in some industries and layoffs in others. For now, it’s holding stronger than desired for the Fed, which wants to see the unemployment rate closer to 4%. It rose to 3.7% in August.
You’d think higher unemployment would be a bad thing, but it’s counterintuitive. This is a case of “bad news is good news.” As the Federal Reserve raises interest rates, investors want to see a softer job market – with higher unemployment – as proof that inflation is finally starting to fall.
At the same time, the housing market is cooling down as mortgage rates hit an average of 6.12% for 30-year fixed-rate loans – the highest rate since 2008. Nearly 20% of homes sold had their listing price reduced, according to an August report from Realtor.com.
Because of these factors, García explains, the market is finding itself in a reset. It’s a great time to start investing in the stock market, especially if you’ve been watching from the sidelines for a while. “This is a really great opportunity for folks to either start learning about the market, start participating, or continue to be diligent in their monthly investments into the stock market,” García says.
Despite what the market is doing, the best course of action is to stick to your plan and to keep investing.
“It’s just temporary at the end of the day,” says García. “And five to 10 years from now, we’ll be looking at this moment and be like, ‘Why didn’t we buy more?’”
Even — and especially — when there’s volatility in the stock market, the best course of action is to be aware, but stick to your investing plans. It’s impossible to time the market, and historically speaking, it’s always recovered. Stay the course through the dips and peaks, and remember why you’re investing.
Will the Stock Market Recover?
This month has a track record of poor performance. September has been the worst-performing month for the S&P 500 since 1950, according to eToro’s historic data.
“Historically, if September’s down, then we move into a fourth quarter of being down,” García says.
From 1921 to 2021, the Dow had 36 years of a losing September that ended with an overall negative year, so there is a correlation that points to an upcoming negative fourth quarter (and year).
And October is notorious for market crashes, including the infamous Black Monday in 1987 and the meltdown that led to the Great Depression in 1929. On the other hand, the market tends to perform well in midterm election years like this one. And, of course, Q4 could see increased consumer spending for a holiday season with reduced COVID-19 concerns.
Whatever happens, experts are expecting a volatile finish to the year – and where it’s headed is anyone’s guess.
Keep in mind that investments easily outpace inflation over time – even with the normal ups and downs of the market. As an investor, the best response is to stay the course and keep investing, regardless of what the market is doing.
How Investors Should Deal With Stock Market Volatility
For new investors, big swings in the market can be a lot to handle. There’s a lot of uncertainty right now because of interest rate hikes, increasing real estate prices, and everyday commodities getting more expensive because of inflation — and the market reflects that on a day-to-day basis.
But if you have a buy-and-hold strategy with low-cost, broad-market index funds, remember that slow and steady wins the race. The best performing portfolios are the ones that have the most time in the market.
“The most important thing is always to remember what you’re investing for,” says Thomas Muñoz, financial life advisor at Telemus, a financial advisory firm. “Short-term volatility is obviously something people should be aware of. But if you have a long-term time horizon, historically the stock market goes up. And when that’s the case, it’s important to have the discipline to keep dollar-cost averaging your [investments].”
Dollar-cost averaging spreads out your deposits over time, and has demonstrated that it performs better “during a period of high market crashes,” says Rebecka Zavaleta, creator of the investing community First Milli.
Whatever you do, invest early and often, especially if you have a long investment timeline. Dips and crashes will happen, and so will other scary-sounding things like economic bubbles, bear markets, corrections, death crosses, and recessions.
You can even take advantage of a dip to invest more, but not if it impacts your regular investing schedule, Muñoz advises. It’s hard to tell when there’s going to be a dip or correction, and “not even the best investors in history can time the market.” The best advice is to stick to your plan and keep investing.